As their enterprise clients move to digital business models, which are clearly superior in productivity, business alignment and speed, legacy service providers seek to shift their offerings to the new digital world too. Seems like a great match, right? So, what’s the problem? The problem is the service providers are accustomed to a very profitable offshore factory delivery model. Inconveniently, the new digital business models don’t align well with this old tried-and-true mainstay. Even more disturbing for the service providers is that the new delivery models look to be less profitable than the mature offshore talent factories. I foresee increasing pressures on margins and some potentially unrecognized consequences that will impact clients.
Two reasons for the margin paradox
As the services industry rotates from the old labor arbitrage model to digital business models, service providers expect to achieve higher margins than their typical 40 percent gross margins. Why? Because the digital models deliver a higher level of value. They are better aligned against clients’ business results and are delivered at a faster rate. So, why are providers shifting to digital not getting even close to maintaining the margins they enjoyed in the labor arbitrage space?
One reason is the price of digital talent. The skillsets for the disruptive technologies are rare and command a higher price. Plus, there is a scarcity of talent with skills and experience in implementing the new models.
A second factor is the difference in teams doing the work. The digital world requires persistent teams that remain over time and are located onshore; the arbitrage world depends on low-cost labor in offshore teams that churn over time.